Diversification, Internal Capital Market, and Information Advantage

Abstract

We analyze the information advantage of insiders and institutional investors from the efficiency of internal capital market defined in Billett and Mauer [1]. The empirical evidence shows three major findings in this paper. First, the inefficient subsidies to constrained firms have significantly negative impact on the firm’s long-term performance. In addition, the diversified firms with transfer segments, both efficient and inefficient transfer, have significantly positive effect on the firm’s performance. Second, the insiders and institutional investors of diversified firms may use similar information regarding the internal capital market because they show the similar trading behavior with respect to efficient subsidies to both constrained and non-constrained segments. Finally, the insiders play a more important role in the firms’ long-term performance. In sum, we conclude that both institutional investors and insiders have some information advantage of internal capital market. Insiders, however, have stronger impact on the diversified firms’ long-term performance.